Figuring out the proper stop loss when day trading, whether experienced or novice, is always a tricky subject. One thing is for sure, if you don't use a stop loss and try to become a trader, there is almost a 100% chance you will lose a significant amount of money, if not all of it. Even using stops, if they are inappropriate, will result in net losses no matter how good the stock pick is. Additionally, adding to positions in front of economic data to be released or other unpredictable events can assure higher odds of getting stopped out because of increased volatility post release.
The major thing to concentrate on is the current market conditions - this is very important. Do not pay attention to what the indexes are doing, it is what many stocks over various sectors are doing overall and how they are trading in general. What is the general volatility level for the day, is stuff trading slow and steady or are they whipping up and down quickly on a slight move in the futures market? This makes a large difference in not only the stop placement, but in the overall risk level for the trade. Most people assess risk by the amount one can lose when using a day trading robot or just trading on their own with chart setups. What most people fail to think about is the actual odds of that loss happening.
While there is no easy formula to figure out the odds, if you watch the pattern of behavior of how similar stocks are trading, you can get a pretty good idea. If conditions are calm, you might be able to use a smaller stop - a 30c stop has a 30% chance of getting hit for example. When conditions are frantic, a smaller stop is almost assured to get hit - meaning the 30c stop has a 98% chance of getting hit even on the exact same name.
The way you figure the odds in a stop happening when day trading is somewhat straightforward. Look at the average range high to low over the last 20 minutes. Do not pick a very calm period of time, as this calmness tends to lead to increased and unpredictable volatility. If the price action currently is very flat and calm, go back on the chart to a more volatile time of the day or prior day and then figure out the range. It does not have to be exact, an approximation is fine. Once you have measured this range, this becomes your maximum risk.
What we want to do is to lower this max amount to a lesser level. This can be accomplished in 2 different ways. The first way is to watch the pattern of trading behavior on the chart of the day traded stock - when it reaches a prior high level, does it push thru and run some, or does it barely touch, then retrace (sell) down? If it starts to push the last few times it reached a high turning point, then it is probably OK to buy the stock on strength. If it tries to sell, or looks like a fade back - wait for it to push and then put your order in at 1/4 of the range computed, but lower than the high its at currently. So if the range was 1.00, and the stock was at 40 now, you would put your order at 39.75 to go long. You will most likely miss some trades doing it this way, but have to ignore the urge to chase the prices. If a similar pattern is occurring on a lot of other stocks (in general) you have to be extra careful.
A second way to remove some of the risk is to split your entry order into 2 different parts. So if your trade size you want is 500 shares, just buy 200 shares now. Wait until the price moves up a decent amount, including past the point where normally they would fade a breakout, and then loOK to add the remainder on a small dip of 5-15 cents or so. Move your stop up .45 now (assuming you had a 1.00 stop to start) on all of it. The other alternative, if the market tends to fade the push moves, is to buy 200 shares now, then put the balance of your order .25 above your stop price level (figuring it is 1.00). The max stop remains the same on all shares. The difference here is if market conditions get poor for going long when day trading for a period of time, you are going to lose a lot more averaging when its selling because you will get filled on the add, then stop out 2 minutes later on all of it.
The easiest way around this situation is to lower your share size - when unpredictability sets in, trade only 1/2 your normal size. The name of the game to being more profitable is to preserve capital with stops, and secondly to place the stops in the right way to avoid making a loss too easy for the market to hit. While is is very difficult to actually tell that trading conditions are improving without actually trading, it is a very good idea to trade with less shares until you visibly see conditions loOK better over time.
Posted by sarahableen20
at 2:59 AM EDT
